The Treaty establishing the European Community assigns the European
System of Central Banks (ESCB) - and thereby the Eurosystem - the primary
objective of maintaining price stability. The Governing Council will do its
utmost to fulfil this task and to explain its monetary policy so as to be
comprehensible to the general public. For this reason we have developed a
stability-oriented monetary policy which essentially consists of three main
elements.
The Governing Council has published a quantitative definition of its
primary objective, price stability. This gives clear guidance for
expectations in relation to future price developments. Price stability is
defined as an increase in the Harmonised Index of Consumer Prices of the
euro area of less than 2% compared with the previous year. The publication
of this definition provides the public and the European Parliament with a
clear benchmark against which to measure the success of the single monetary
policy, and thereby provides for the transparency and accountability of the
Eurosystem and its policy.
The wording "less than 2%" clearly defines the upper limit for the
measured inflation rate which is compatible with price stability. I do not
think I need emphasise that deflation - or a sustained fall in prices -
would be incompatible with price stability. The latest available data for
the annual rate of inflation according to the Harmonised Index of Consumer
Prices for the euro area as a whole fall within the definition of price
stability. This outcome is clearly the result, above all, of the successful
monetary policy of the national central banks in the years before the start
of Monetary Union.
The ECB has only been responsible for monetary policy for a little more than one month. It will only be possible to judge the success of its current policy in one to two years'time. This reflects the fact that the transmission of monetary policy impulses is subject to relatively long and variable time lags. The Governing Council has therefore emphasised that price stability must be maintained in the medium term. This statement underlines not only the need for a forward-looking approach to monetary policy, but also takes into consideration the short-term volatility of prices in response to non-monetary shocks which are beyond the control of monetary policy.
In order to achieve the goal of price stability, our strategy rests, in particular, on two "pillars". Before I explain this in more detail, I should like to emphasise that traditional and previously established macroeconomic relationships could change as a consequence of the introduction of the euro. This was one key reason why neither a monetary targeting nor a direct inflation targeting strategy could be applied. Our strategy is also more than just a simple combination of these two approaches. Rather, it is precisely tailored to the needs of the ECB.
The first pillar of the monetary policy strategy is a prominent role for money. Since inflation is ultimately a monetary phenomenon in the medium term, the money supply provides a natural "nominal anchor" for a monetary policy geared to safe-guarding price stability. To emphasise this prominent role, the Governing Council has published a quantitative reference value for growth in the money supply. The first reference value decided upon by the Governing Council for growth in M3 was 4.5% per annum and was published on 1 December. This value is based on the above-mentioned definition of price stability and assumes a trend growth in real gross domestic product of 2-2.5% per annum, as well as a medium-term reduction in the velocity of circulation of M3 of around 0.5-1% per annum.
We shall not, however, respond mechanistically to deviations from the reference value for money supply growth, but shall first analyse them carefully for signals relating to future price developments. Larger or sustained deviations normally signal risks to price stability.
The second pillar of the monetary policy strategy consists in a
broadly based assessment of the outlook for price developments in the
entire euro area. This assessment will be based on a broad range of
monetary policy indicators. In particular, those variables which could
contain information on future price developments will be analysed in depth.
This analysis should not only provide information on the risks for price
development, but should also help to identify the causes of unexpected
changes in important economic variables.
Some commentators reduced this comprehensive analysis to an inflation
forecast. At the same time, there were demands for the ECB to have to
publish these forecasts in order to satisfy the need for transparency and
accountability. Therefore allow me to make this clear: our strategy
includes a comprehensive analysis of numerous indicators and several
forecasts. To focus on a single official inflation forecast of the
Eurosystem for a specific point in time would in no way accurately reflect
our internal analytical and decision-making process. It would impinge upon
the transparency and clarity of the explanation of our policy. The
publication of an official inflation forecast would also be inappropriate
with regard to the accountability of the ECB, all the more so if this
forecast were based on the assumption of no change in the monetary policy.
The success of the monetary policy of the ECB should primarily be measured
in terms of the maintenance of price stability, not the accuracy of its
conditional forecasts.
The stability-oriented monetary policy strategy of the Eurosystem, which I have just outlined, constitutes a new and clear strategy. It emphasises the primacy of the goal of price stability. It takes into account the inevitable uncertainties concerning economic relationships inherent in the transition to Monetary Union and the associated systemic changes and guarantees a high degree of transparency.
Ladies and gentlemen, allow me to comment on certain suggestions on the orientation of monetary policy which have recently appeared in the press. Some of these ideas give the impression that monetary policy should concentrate upon objectives other than price stability, since stable prices have already been achieved. Inter alia, it has been suggested that the ECB should react more or less mechanistically to exchange rate developments or other variables such as, for instance, unit labour costs. Furthermore, there were calls for monetary policy, by means of reductions in interest rates, to be used to combat unemployment. Against this background there is a need to set out clearly the possibilities and limitations of monetary policy.
Both the reasoning in the Maastricht Treaty and many economic
analyses show that the best contribution the single monetary policy can
make to employment growth is to concentrate on price stability. Without
such a clear approach there is a danger that the public may question the
commitment of the Eurosystem to the goal of maintaining price stability.
Inflation expectations, risk premia and thus long-term rates would rise.
This would increase the cost of the investment which is necessary for a
sustained and lasting rise in the standard of living.
Even under the best possible circumstances, though - i.e. if it proves to be possible to assure lasting price stability - monetary policy alone cannot solve the major economic problems of unemployment and future problems in social security systems.
The Governing Council regards the current high level of unemployment
in the euro area as a matter of great concern. This problem is, however,
predominantly a structural one. It is mainly the result of the rigidities
in the labour and goods markets in the euro area which have arisen partly
through an excessive and disproportionate degree of regulation. Structural
economic reforms, which target the reduction of rigidities, are the
appropriate solution. In those euro area countries in which such reforms
have been implemented unemployment figures have declined markedly. In
addition, I should like to emphasise that moderate wage developments and a
reduction in the burden of tax and social security contributions would
generally help to reduce unemployment. This would be the case even if the
country concerned did not trade heavily with its neighbouring countries.
The positive influence of low taxes and wages on employment clearly has
overall benefits from an international perspective. Such a policy should
not be denounced as "wage dumping".
Turning to the role of exchange rates between the euro and other
important currencies outside the EU, in particular the US dollar, the
Eurosystem has, in formulating its monetary policy strategy, made an
unambiguous choice. This strategy clearly rules out explicit or implicit
objectives or target zones for the euro exchange rate. The pursuit of an
exchange rate objective could easily jeopardise the maintenance of the
objective of price stability and could thereby also be detrimental to real
economic development. Target zones for exchange rates could, for example,
lead to the ECB having to raise interest rates in a recession, despite
increasing downward pressure on prices. I am sure you will agree that such
a mechanistic response to a change in the euro exchange rate would not be
optimal. Furthermore, it is important to remember that we are living in a
world with high capital mobility. Exchange rate agreements, which might
have been possible to implement until recently, are no longer feasible.
The lack of an exchange rate target does not mean that the ECB is totally indifferent to or takes no account of the euro exchange rate. On the contrary, the exchange rate will be observed and analysed as a potentially important monetary policy indicator in the context of the broadly based assessment of the outlook for price developments. A stability- oriented monetary and fiscal policy, as stipulated by the Maastricht Treaty and the Stability and Growth Pact, is an essential pre-condition for a stable euro exchange rate. Of course, there is no guarantee of lasting exchange rate stability, not even in a fixed exchange rate regime. Exchange rate fluctuations are often caused by structural or fiscal policy, asymmetric real shocks or conjunctural differences. Monetary policy would clearly be overburdened if it had to prevent such movements in the exchange rate.
We cannot and shall not gear our monetary policy towards a single variable, whether a money supply aggregate, an index, the exchange rate or an inflation forecast for a particular point in time. Nor can we be involved in any ex ante co-ordination which would entail an obligation to react to particular commitments or plans. The ECB will always carefully analyse all relevant indicators. In this context, it is particularly important that the economic causes of potential risks to price stability in the euro area are understood as fully as possible. Appropriate monetary policy decisions also depend upon the causes of unexpected changes in important economic variables. The Governing Council must, for example, take a view on whether changes in important indicators are of a temporary or permanent nature, and whether a demand or supply shock is involved. In our deliberations we also attempt to take into account how the financial markets, consumers and firms are expected to react to monetary policy decisions. I believe few would contest that such a complex analysis cannot meaningfully be reduced to a more or less mechanistic reaction to a few variables or a single official forecast.
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